System and method for risk management

ABSTRACT

A margin requirement is computed while trading. The margin requirement may be calculated while trading because the preferred system takes into account working orders to generate the margin requirement. The on the fly possibility allows the preferred system to provide pre-trade risk calculations, but can also be used to provide post-trade calculations. A generic spread number and the maximum number of outright positions are determined. Using the spread positions and the maximum number of outright positions, a spread margin and an outright margin are calculated, which when summed provide a total margin requirement. Limits based in part on the total margin requirement may be imposed on one or more traders.

CROSS-REFERENCE TO RELATED APPLICATIONS

This application is a continuation of U.S. patent application Ser. No.12/559,480, which was filed on Sep. 14, 2009, and which issued on Aug.2, 2011 as U.S. Pat. No. 7,991,667. The Ser. No. 12/559,480 applicationis a continuation of U.S. patent application Ser. No. 10/339,947, whichwas filed on Jan. 10, 2003, and which issued on Oct. 13, 2009 as U.S.Pat. No. 7,603,303. The present application also claims priority to U.S.Provisional Patent Application Ser. No. 60/429,185, which was filed onNov. 26, 2002, and is currently expired. The entire contents of the Ser.No. 12/559,480 application, the Ser. No. 10/339,947 application, and the60/429,185 application are hereby incorporated herein by reference.

FIELD OF THE INVENTION

The present invention is related to electronic exchanges and inparticular, the present invention is directed towards a system andmethod for risk management.

BACKGROUND OF THE INVENTION

An electronic exchange provides a matching process between buyers andsellers. Some well known electronic exchanges include Eurex, LondonInternational Financial Futures and Options Exchange (“LIFFE”),Euronext, Chicago Mercantile Exchange (“CME”), Chicago Board of Trade(“CBOT”), Xetra, and Island. Buyers and sellers, collectively referredto as traders, are typically connected to one or more electronicexchanges by way of a communication link. The traders submit buy or sellorders to the electronic exchange over the communication link. They alsoobtain price information and order fill information from the exchange.

Electronic exchanges are becoming successful venues for trading. Indeed,an increasing number of people are actively participating in a market atany one given time. The increase in the number of potential marketparticipants has advantageously led to, among other things, a morecompetitive market and greater liquidity than with traditional methodsof trading, such as open outcry.

Traders sometimes prefer to trade only one tradable object at a time,and sometimes traders wish to trade more than one tradable object at atime in a strategy referred to as spreading or strategy trading. As usedherein, tradable objects may include, but are not limited to, all typesof traded financial products, such as, for example, stocks, options,bonds, futures, currency, and warrants, as well as funds, derivativesand collections of the foregoing. Moreover, tradable objects may includeall types of commodities, such as grains, energy, and metals. A tradableobject may be “real”, such as products that are listed by an exchangefor trading, or “synthetic”, such as a combination of real products thatis created by the trader. A tradable object could actually be acombination of other tradable object, such as a class of tradableobjects.

As mentioned above, some traders trade one tradable object. For example,a trader might trade the June 2002 corn contract. That is, the trader isoffering to buy or willing to sell the corn contract, depending on hisor her trading strategy. Likewise, a trader might trade a December 2003corn contract, a corn contract from another month or another type ofcontact altogether. As is common, however, traders may trade more thanone tradable object at a time. For example, a trader may buy multipledifferent tradable objects, sell multiple different tradable objects, orbuy and sell a combination of different tradable objects. While thedifferent buys and sells may comprise unrelated positions for thetrader, they may alternatively be part of a specific tradingstrategy—such as a spread.

Spreading is a trading strategy that traders might use to hedge risk.That is, a spread can be used to reduce the trader's downside risk oftrading a tradable object. A spread generally includes buying at leastone tradable object and, usually at the same time, selling at least onedifferent tradable object. For example, a trader could spread trade theJune 2002 corn contract and the December 2003 corn contract, such asbuying the June 2002 corn contract and selling the December 2003 corncontract, or vice versa.

In this example, the June/December corn contract spread has two legs.The June 2002 corn contact makes one leg, while the December 2003 corncontract makes the second leg. The legs refer to the portions of thetrade associated with each individual tradable object, which can also bereferred to as an outright market. A spread, however, can have more thantwo legs. Additionally, spreads can be created based on relationshipsother than calendar months. One such example would be trading a 10 yearnote and a 5 year note, however, other examples also exist.

As previously described, spreads may reduce a trader's downside riskwhen compared to trading a single outright position. The tradableobjects comprising the legs of a spread ordinarily share a pricecorrelation. Thus, their prices generally move in the same direction.For example, a decrease in the price of one leg would then generallycorrespond to a decrease in the price of another leg. Placing opposingtrades, such as buying one leg and selling the other leg, reduces thepotential downside risk, because a decrease in the price of one leg(e.g., the buy leg) that causes the trader to lose money would be offsetby the corresponding decrease in the price of the other leg (e.g., thesell leg) that causes the trader to gain money.

Common to trading most tradable objects, when a trader places an orderfor a tradable object, the trader needs only to put up a fraction of thevalue of the tradable object. This is oftentimes referred to as margintrading, and it allows the trader to trade a much larger amount of thetradable object than if the trader simply bought or sold the tradableobject outright (e.g., by paying cash). In order to trade on margin, atrader generally deposits a certain amount of cash in a margin accountwith a trading house, which the trader uses to access the exchange. Inreturn, the trading house grants the trader a margin balance, which istypically greater than the amount of cash the trader deposited in themargin account. The trader can then buy and sell tradable object againstthe margin balance.

Each tradable object position held by a trader, whether a long positionor a short position, has associated with it a margin requirement,sometimes also called a margin amount. The margin requirement generallyrefers to an amount of margin required to hold that position. When thetrader's initial order for position is filled, the margin requirementfor that position is deducted from the trader's margin account. Themargin requirement for that position, however, does not necessarilyremain fixed. Changes in the market price for the position may cause acorresponding change in the position's margin requirement, thereby alsoaffecting the balance in the trader's margin account. Of course, factorsother than the market price for the position may alter the marginrequirement.

Usually, a clearing house computes the margin requirements after everytrading session, sometimes referred to as post-trade risk calculation.There are many different types of margin requirements usually dependingon the type of tradable object and clearing house. However, in general,a spread position is usually considered to be a lower risk strategy thanan outright long or an outright short position, and therefore marginrequirements for spreads are often much less than for outrightpositions. For example, if the price trend of a tradable object iscurrently up and the trader is in a spread, (e.g., short one month andlong another) the gain on the long position would likely offset the lossof the short position, and vice-versa. One side of the spread typicallyhedges the other, therefore the lower margin requirements.

One well known tool for computing margin requirements in circumstancessuch as these is Standard Portfolio Analysis of Risk (“SPAN”), which isa margining system developed by the Chicago Mercantile Exchange (“CME”).SPAN uses a set of pre-determined parameters set by the clearing houseto assess what the maximum potential loss will be for a given portfolioover a one-day period. SPAN and systems like SPAN are typically used atthe end of the trading day to recompute margin requirements for atrader's outstanding positions and thereby to also recompute theavailable margin in the trader's margin account.

The parameters used by SPAN in computing the margin requirements cantake into account various different factors. For example, SPAN canrecognize that two opposing outright positions of similar tradableobjects (e.g., a buy of one tradable object and a sell of anothersimilar tradable object) may in fact comprise a spread. Thus, instead oftrading the spread as a single tradable object (e.g., trading in aspread market), the trader may have separately purchased the legs of thespread (e.g., trading individual legs in an outright market). Aspreviously explained, the spread has less of a risk associated with itthan with uncorrelated outright positions. Therefore, the two outrightpositions comprising the spread should have a lower margin requirementthan if they were considered as separate outright positions.

The margin requirement calculations performed by SPAN, while accountingfor many different market factors, are computationally intensive.Therefore, they are not well suited for real-time use while the exchangeis open for trading. If they were used during the trading day, forexample as a pre-trade calculation to determine if a trader has enoughavailable margin to place a trade, they would cause an unreasonabledelay in executing the trade. This may cause the trader to miss placingthe trade, for example, if the market had already moved away from thetrader's order price, or they may cause the trader to have a lessadvantageous position in the queue for open orders at the particularprice level for that trade. Additionally, as SPAN was designed for useat the end of the trading day, it does not take into account the marginrequirements of working orders.

In spite of the limitations of SPAN, trading houses and individualtraders still attempt to keep track of their margin requirementsthroughout the day; however, this is currently done with much moresimplistic methods. Current pre-trade calculations are usually done bydetermining the number of markets in which a trader has a position andthen multiplying those positions by the margin requirement for outrightlegs. These quick calculations are not sophisticated enough to determinewhich of the outright positions may in fact comprise legs of a spread.Therefore, such calculations assume that the trader is only trading inoutright long or short positions and not spread positions. As a result,the margin requirements are typically higher than they should be, whichis not an accurate representation of the true margin requirements of thepositions taking into account spreads and other trading strategies.

Therefore, there exists a need for an improved risk management systemthat can be used for real time pre-trade risk calculations.

DETAILED DESCRIPTION OF THE DRAWINGS

The presently preferred embodiments of the present invention aredescribed herein with reference to the drawings, in which:

FIG. 1 shows a system in accordance with the preferred embodiments forreceiving inputs and for determining a margin requirement based on thereceived inputs;

FIG. 2 shows a system in accordance with the preferred embodiment forreceiving a computed margin and one or more limits and for determiningwhether to apply any limits to an order;

FIG. 3 shows a method in accordance with the preferred embodiment fordetermining the number of spread positions;

FIG. 4 shows a method in accordance with the preferred embodiment fordetermining the maximum number of outright positions; and

FIGS. 5-10 show example inputs into the preferred system of FIG. 1,result of the calculations performed by the system, and the system'soutput including the computed total margin requirement.

DETAILED DESCRIPTION OF THE PRESENTLY PREFERRED EMBODIMENT I. Overview

A system and method are described herein to calculate a marginrequirement on the fly while trading, if so desired. The marginrequirement may be calculated on the fly because it takes into accountworking orders to generate the margin requirement. The on the flypossibility allows the preferred system to provide pre-trade riskcalculations. Pre-trade calculations generally refer to calculating themargin throughout the trading day, rather than just at the end of theday. Alternatively, the system can be implemented at the end of the dayor at any other time to provide post-trade risk calculations.

Using the system of the preferred embodiment, certain limits based onthe computed margin requirement can be imposed on one or more traders.These imposed limits are more realistic than previously possible with aconventional system because the preferred system accounts for ordersthat are working in various markets (e.g., outright markets and/orexchange spread markets) in addition to the trader's filled net positionto generate a number of spreads and a number of outrights. Then, a moreaccurate margin requirement may be calculated based on the computednumber of spreads and the computed number of outrights, which bettermodels the potential risk. As a result, the trader or traders can bemore confident that the computed margin requirement is more accurate andthus the limits imposed on them are more realistic than previouslypossible.

Many of the preferred system's users in various standing throughout thetrading industry may benefit from the present invention. For example, anindividual trader may use the preferred system at his or her tradingterminal to track the margin requirement in real-time, thereby allowingthe trader to readily use and/or view the margin available for futuretrades. The trader could also impose limits or restrictions on his orher trading as a result of the computed margin requirement. However, thesystem is not limited to individual traders, for instance, the preferredsystem can provide a margin requirement for a group of traders. Limitscould then be imposed on the group of traders. Additionally, anadministrator/risk manager at a trading house, at a clearing house, atan exchange or some other trading related entity may use the system tocalculate margin requirements for one or more traders. They can use thepreferred system, for example, to determine whether a trader has enoughavailable margin for an order prior to submitting the order to anexchange. Then, for example, limits based in part on the computed marginrequirement may be manually or automatically imposed on a trader orgroup of traders to restrict one or more of the traders from submittingorders. Other uses of the present invention will become readily apparentto one skilled in the art of trading from the description providedherein.

The present invention now will be described more fully hereinafter withreference to the accompanying drawings, in which preferred embodimentsof the invention are shown. This invention may, however, be embodied inmany different forms and should not be construed as limited to theembodiments set forth herein.

II. Software Overview

FIG. 1 shows a spread risk calculator 100 for receiving inputs and fordetermining a margin requirement based on the received inputs. Thespread risk calculator 100 shown in the Figure exemplifies its modulararchitecture. That is, it is designed as a stand-alone unit that canwork with other sections of a trading program, or the same module mightbe able to perform the same task in another program as well.Alternatively, the spread risk calculator 100 can be part of anintegrated architecture, in which no particular divisions exist betweencomponents. Regardless of whether the spread risk calculator 100 is partof a modular or integrated architecture, the program may reside on anycomputing device such as a server, workstation, desktop computer, laptopcomputer, hand-held device, and so on to compute the margin requirement.Additionally, it can be programmed using one or more of a variety ofdifferent programming languages known in the art, such as C, C++, Java,Perl, or others. The system may also be programmed using a third-partysoftware program, such as a well-known spreadsheet application providedby Microsoft® Excel.

The spread risk calculator 100 is presently programmed to receive atleast some of the following inputs. They include base margins such as abase spread margin and a base outright margin (the base spread marginand the base outright margin are together referred to as “BaseMargins”), filled net long position (“Filled Net Long Position”), fillednet short position (“Filled Net Short Position”), working outrightorders (“Working Outright Orders”), working spread orders (“WorkingSpread Orders For Exchange Spreads”), and an attempted order (“AttemptedOrder”) which is described more below. These inputs may be in the formof parameters that are stored in memory and which are accessed by thespread risk calculator 100. Regardless of how the spread risk calculator100 receives the inputs, as the input values change, it is preferablethat the spread risk calculator 100 at least has access to the updatedinput values.

An attempted order is an order that a user or trading application isattempting to send to an exchange. Then, the system preferably uses theinventions described herein to determine whether to allow the attemptedorder to be sent to the exchange based on the margin risk analysis. Inthe preferred embodiment, the spread risk calculator 100 treats theattempted order as either a working outright order or a spread order.For instance, if a trader attempts to buy an exchange provided spread,the system will preferably treat this input as a working spread orderfor purposes of the margin requirement calculation. In another instance,if a trader attempts to buy a tradable object in an outright market, thesystem will preferably treat this input as a working outright order forpurposes of the margin requirement calculation. Then, in eitherinstance, the system could determine whether to send the attempted orderto the exchange based on the computed margin requirement and anavailable margin account balance.

The spread risk calculator 100 is presently programmed to calculatecertain variables which are used to compute the margin requirement.Although these variables are described in greater detail below theyinclude maximum leg positions, a total maximum leg position, a number ofspreads (also referred to herein as a generic spread number), a numberof outrights, and a maximum number of outrights. Using at least thesevariables, the preferred system then computes a spread margin and anoutright margin. The spread margin is based on the number of spreads andthe base spread margin value. The outright margin is based on themaximum number of outrights and the base outright margin value. Both thebase spread margin value and the base outright margin value are set bythe user, trading house, clearing house, and/or exchange. Then, thetotal margin requirement is the summation of the spread margin and theoutright margin. The total margin requirement is output of the spreadrisk calculator 100.

FIG. 2 shows a limit module 200 for receiving a total margin requirementand one or more limits for determining whether to send an order, rejectan order, or modify an order to fit within the limits. The limit module200, like the spread risk calculator 100, is part of a modulararchitecture. Alternatively, the functionality of the limit module 200may be programmed into an integrated architecture. The limit module 200may reside on the same machine as the spread risk calculator 100, or itmay reside on a separate machine. Any type of computing device such asthose enumerated above with respect to the spread risk calculator 100can be used to implement the limit module 200.

The limit module 200 is presently programmed to receive the marginrequirement and one or more limits. Limits might include sending theorder to the exchange if the margin balance is greater than the marginrequirement and/or refraining from sending the order if the marginbalance is less than the margin requirement. Then, the limit module 200can be programmed to send a signal that indicates whether an attemptedorder should be sent or rejected. If the attempted order is rejected, itis not sent to the exchange. If desired, the rejected order may bedeleted or queued for later use depending on how the system isprogrammed. Limits could be input by a trader or an administrator, forinstance.

III. Preferred Methods for Computing a Margin Requirement

As described above, in the preferred embodiment, a spread margin and anoutright margin are computed, which when summed together provides amargin requirement. Preferably, the margin requirement is computed everytime there is an attempted order. Alternatively, the margin requirementcan be computed at any time including when one of the input valueschanges.

The computed margin requirement can be used in many ways. For instance,as described with respect to FIG. 2, the computed margin requirement isused to limit or restrict the trading of one or more traders. That is,based on the computed margin requirement and one or more pre-set limits(e.g., user defined limits), for instance, an attempted order could besent to the exchange or an attempted order could be prevented from beingsent to the exchange. FIGS. 3 and 4 characterize preferred processes forcomputing a spread margin and an outright margin, respectively.

FIG. 3 shows a flowchart 300 illustrating a preferred method forcomputing a spread margin based on a calculated generic spread number.The generic spread number represents the possible number of spreads thatcould exist based upon the total maximum leg position and the totalfilled net position. To calculate the generic spread number eachtradable object traded by the trader is being considered as a leg of aspread. The maximum leg position represents the maximum position in eachsuch leg. Examples with actual numbers are described below to illustratethe relationships described in flowchart 300. Additionally, it should beunderstood that the steps may be arranged in a different order oreliminated altogether unless otherwise noted. For example, according toflowchart 300, the order of steps 302 and 304 may be swapped.

At step 302, the total maximum leg position is determined. In thepreferred embodiment, the total maximum leg position is the summation ofthe maximum leg positions for each tradable object. The maximum legposition for each tradable object is equal to the maximum of (absolutevalue (filled net long position−filled net short position+equivalent buyleg spread position), absolute value (filled net long position−fillednet short position−equivalent sell leg spread position)). The equivalentbuy leg spread position and the equivalent sell leg spread position areworking orders that might be necessary to accomplish a spread order foran exchange provided spread. That is, the preferred system receives aspread order (or an attempted spread order) and preferably breaks downthe spread order into equivalent buy/sell leg positions. For example,when a trader buys a March/June spread, the system would generate anequivalent buy position in March and an equivalent sell position inJune. However, it is envisioned that some exchanges could break downspread orders into the leg positions and provide such information in itsmessages to the client devices. In such a case, it would not benecessary for the preferred system to perform the breakdown.Additionally, the equivalent buy/sell leg positions preferably includeany attempted spread orders for an exchange provided spread. That is,when a trader attempts to buy or sell an exchange provided spread, thesystem preferably breaks down the attempted spread order into equivalentbuy/sell leg positions.

According to the preferred embodiment, the computation of the maximumleg position does not take into account working orders in the outrightmarkets. Instead, the outright working orders are taken into account inthe calculation of the maximum number of outrights described withrespect to FIG. 4.

At step 304, outrights is determined. Outrights (e.g., the absolutevalue of the total net position) represents the number of total outrightpositions, or equivalently, the number of positions (e.g., buy or sell)that are not considered part of a spread. The outrights is equal to theabsolute value of (total filled net long position−the total filled netshort position). The total filled net long position is the sum of allfilled net long positions for each tradable object. The total filled netshort position is the sum of all filled net short positions for eachtradable object.

At step 306, the number of spreads is determined. In the preferredembodiment, the number of spreads is equal to the (total maximum legposition−outrights)/2. Note that the reason for dividing by two is thata calendar spread contains two legs, which is described more below.

According to the preferred embodiment, the number of spreads issometimes referred to in this application as the generic spread numberbecause the preferred system does not have to necessarily matchleg-to-leg to form identified spreads. For instance, assume tradableobjects “A,” “B,” “C,” and “D” were being traded, where “A” and “B” arelegs to “Spread 1” and “C” and “D” are legs to “Spread 2.” According tothe preferred embodiment, it is not necessary that the legs “A” and “B”are matched to “Spread 1” and it is not necessary that the legs “C” and“D” are matched to “Spread 2.” It should be understood, though, that thelegs could be matched to particular spreads if programmed to do so.

Once the number of spreads (generic spread number) is determined, it maybe used to compute the spread margin by multiplying the number ofspreads by a base margin value for spreads. Recall that base marginvalues for spreads are generally less than base margin values foroutright positions. As described above, the total margin required canthen be computed by adding the spread margin to the outright margin.Calculation of the outright margin is outlined with respect to FIG. 4.

FIG. 4 shows a flowchart 400 illustrating a preferred method forcomputing an outright margin based on maximum outrights. Maximumoutrights represents the maximum number of outright positions that couldbe possible with the current configuration of outright market workingorders and filled positions. Maximum outrights preferably takes intoaccount both working buy outright orders and working sell outrightorders entered by the trader(s) into outright markets.

At step 402, the number of outrights due to working buy outright ordersand the total filled net position is determined. For each tradableobject there may be orders working (or resting) in the outright markets.Step 402 preferably takes into consideration any such working buy orderseven though they have not been filled. Step 402 results in a numberequal to the absolute value of (total filled net position+working buyoutright orders).

At step 404, the number of outrights due to working sell outright ordersand the total filled net position is determined. Again, for eachtradable object there may be orders working (or resting) in the outrightmarket. Step 404 preferably takes into consideration any such workingsell orders even though they have not been filled. Step 404 results in anumber equal to the absolute value of (total net position−working selloutright orders).

With respect to steps 402 and 404, the number of outrights due toworking buy and sell orders preferably includes any attempted outrightorders. That is, when a trader or trading application attempts to send abuy or sell order, the system includes those in the working buy and sellorders. Then, for example, the system can determine whether the ordershould be sent to the exchange based in part on the computed marginrequirement.

At step 406, maximum outrights is determined. In the preferredembodiment, maximum outrights is equal to the maximum of the result fromstep 402 and the result from step 404.

Once maximum outrights is determined, it may be used to compute theoutright margin by multiplying maximum outrights by a base margin valuefor outright markets. Then, the total margin required can then becomputed by adding the spread margin to the outright margin. Note thatif a group of traders were being monitored by the system, according tothe preferred embodiment, the total margin requirement for each traderis added together to provide a total margin requirement for the entiregroup.

IV. Examples for Computing a Margin Requirement

FIGS. 5-10 show example inputs and a margin requirement output from amodule that operates substantially similar to the spread risk calculator100 described with respect to FIG. 1. Although the formulas forcomputing the margin requirement have been introduced above, they areagain described below.

Turning now to the Figures. Each of the Figures is filled with exampleinformation for trading tradable objects for the months of March(“MAR”), June (“JUN”), September (“SEP”), and December (“DEC”). TheFigures may include information for a greater or fewer number oftradable objects, and therefore a greater or fewer number of months maybe included. Also, the Figures may include information for differenttradable objects, and therefore different months may also be used.

Of course, it should also be understood that a tradable object may beidentified using a variety of different identifiers, and it is notnecessary that a tradable object only be identified by a correspondingmonth. Also, the tradable objects illustrated in FIGS. 5-10 are tradableobjects for different delivery months (e.g., expiration dates); however,some types of tradable objects may be listed according to differentstrike prices instead of delivery months, or they may be listedaccording to some other relationship.

Inputs into the system include the filled net long position (“Filled NetLong Position”), filled net short position (“Filled Net ShortPosition”), working buy and sell outright orders for the outrightmarkets (“W Buy” and “W Sell” under “Outright Positions”), and buyand/or sell spread orders for exchange provided spreads in which thesystem breaks this input down into equivalent positions in the legs ofthe spread (“W Buy” and “W Sell” under “Positions Based on Spreads”).Alternatively, as described above, an exchange and/or gateway couldbreak this spread order input down and provide the equivalent positions(e.g., “W Buy” and “W Sell”) in the legs of the spread.

The Figures additionally show values that are preferably calculated bythe system. They include a maximum leg position (“Max Leg Position”), anumber of spreads (“Spreads”), a number of outrights (“Outrights”), andmaximum number of outrights (“Max Outrights”). Also included are thespread margin base (“S-Margin” “Base=10”) and the outright margin base(“O-Margin” “Base=100”). These base values (e.g., “10” and “100”)represent an amount of margin required to purchase a particular tradableobject and can be adjusted accordingly. For example, as shown inFigures, the spread margin base has a value of 10, while the outrightmargin base has a value of 100. Thus, the amount deducted from thetrader's margin balance for trading a spread would be one-tenth theamount deducted for trading an outright object of the same price. Ofcourse, these values are merely examples. They can be set to any othervalues or ratios, and they can be set by various different factors. Forexample, the values may change depending on the margin base values givenby a trading house, clearing house and/or exchange. Another calculatedvalue is the total margin requirement (“Total Margin”). These show therelative margin requirements and the total margin requirement for thetrader's outstanding positions. According to the preferred embodiment,the computed margin requirement is preferably output from the module andused accordingly.

The relationships, first introduced with respect to FIGS. 3 and 4, whichare used to calculate some of the variables shown in FIGS. 5-10 aredescribed directly below, as shown in the following formulas:

(1) Total Filled Net Long Position=summation of each filled net longposition for each of the tradable objects. In this example, there are“4” months and hence four tradable objects. For example, total fillednet long position=filled net long position for March+filled net longposition for June+filled net long position for September+filled net longposition for December.(2) Total Filled Net Short Position=summation of each filled net shortposition for each of the tradable objects. For example, total filled netshort position=filled net short for March+filled net short forJune+filled net short for September+filled net short for December.(3) W Buy Total (Outright Positions)=summation of each working outrightbuy order for each of the tradable objects, or in this example, for eachof the 4 months. These represent working orders for tradable objects.(4) W Sell Total (Outright Positions)=summation of each working outrightsell order for each of the tradable objects, or in this example, foreach of the 4 months. These represent working orders for tradableobjects.(5) W Buy (Positions Based on Spreads)=represents an equivalent of aworking buy order in a leg of a spread offered by an exchange thatguarantees fills in both legs (e.g., such as provided by the exchange“LIFFE”). For example, as described above, if a trader places an orderto buy one exchange provided March/June spread, that spread order can berepresented by a W Buy in March and a W Sell in June. According to thepreferred embodiment, the orders that the exchange are entering areshown in the Figures under the “Positions Based on Spreads” column.(6) W Sell (Positions Based on Spreads)=represents an equivalent of aworking sell order in a leg of a spread offered by an exchange thatguarantees fills in both legs (e.g., such as provided by the exchange“LIFFE”). See, for example, the discussion above with respect to W Buy(Positions Based on Spreads).(7) Total Maximum Leg Position=summation of each maximum leg positionfor each of the tradable objects, and in this example, for the 4 months.(8) Maximum Leg Position (e.g., March)=the maximum of (absolute value(Filled Net Long Position−Filled Net Short Position+W Buy (PositionsBased on Spreads)), (absolute value of Filled Net Long Position−FilledNet Short Position−W Sell (Positions Based on Spreads)). Maximum legposition is the maximum position possible with respect to filledoutright orders, filled spread orders, and working spread orders.Working spread orders are taken into account here as once they arefilled, they will be spreads. Recall from FIG. 3, that from this maximumleg position, the number of spreads (generic spreads) can be determined.(9) Spreads=(Total Maximum Leg Position−Outrights)/2. As describedabove, this is divided by 2 to account for calendar spreads where thereare two legs. This value also represents the generic spread position. Insituations where a spread has more than two legs (e.g., butterfly spreadwith 3 legs or a condor spread with 4 legs), the system preferablybreaks the multi-legged spread into a 2-legged spread and then analyzesit according to the relationships described herein. For non net-zerospreads such as a pack, bundle, or strip spread, the system preferablyevaluates them as outright positions. Additionally, if the spreadsresults in a fraction (e.g., 0.5, 1.5, etc.) then a less conservativesolution would include rounding down this value (Spreads) to the nextclosest integer. Alternatively, one could round up to the next closestinteger, but that might result in having more spreads and a moreconservative estimate of the margin requirement.(10) Outrights=Absolute value (Total Filled Net Long Position−TotalFilled Net Short Position). This is equivalent to the absolute value of(Total Net Position).(11) Max Outrights=The maximum of (absolute value (Total Filled Net LongPosition−Total Filled Net Short Position+W Buy Total (Outrights)),absolute value (Total Filled Net Long Position−Total Filled Net ShortPosition−W Sell Total (Outrights))).(12) S-Margin=Spreads*Base (S-Margin). The Base for spreads is set to“10,” however, it should be understood that this value could be changed.For example, the base for spreads could be set to some different value.As illustrated in the preferred embodiment, the same base value is usedfor all spreads, and therefore, all spreads have the same marginrequirement. In an alternate embodiment, different spreads can havedifferent base values, and therefore also different margin requirements.This can be used, for example, to take into account the relative risk ofdifferent spreads. Spreads that have a closer price correlation betweenthe legs will generally be less risky than spreads where the pricecorrelation between the legs is not as strong. In one embodiment, thesystem can use a lower base value, and thereby also a lower marginrequirement, for spreads where the legs are more closely correlated. Forexample, when the expiration dates of the legs of a spread are closertogether (e.g., a January 2003/February 2003 spread) there willgenerally be a stronger price correlation between the legs than in aspread where the expiration dates of the legs are farther apart (e.g.,January 2003/August 2003 spread). The system can accordingly use a lowerbase value in computing the margin requirement for the less risk spread.(13) O-Margin=Max Outright*Base (O-Margin). The Base for outrightpositions is set to “100,” however, it should be understood that thisvalue can change.(14) Total Margin=S-Margin+O-Margin. This value represents the computedmargin requirement.

In the simplest case, to determine the maximum number of outrightpositions and/or spread positions, the system preferably examines thecomputed total net long and total net short values. The lesser of the ofthe two values represents the generic spread number; the differencebetween both preferably constitutes the maximum outrights. In othersituations, the system preferably takes into account working orders inthe outright markets and/or working orders in the spread market whencomputing the generic spread number and the maximum number of outrights.In such cases, the generic spread position (or “Spreads”) can be foundusing equation (9) above. The maximum number of outrights (or “MaxOutrights”) can be found using equation (11) above. Some examples areprovided below to assist in illustrating some of the previouslydescribed relationships.

A. Example 1

FIG. 5 shows a working buy order placed in an outright market for March.Once the order is placed (note that the order could be an attemptedorder), the maximum outright position changes to “1.” The maximumoutright position would occur if the order fills, thereby generating aone outright position for the trader. Note that the outright value is“0,” because the buy order is still working and has not yet been filled.Thus, while the order is pending the trader has no outright positions.The O-Margin position is 100*1=100. The total position is 0+100=100. Thetotal position represents the margin requirement of “100.” If theworking buy order was an attempted order, the preferred system coulddetermine based on the margin requirement and the available marginbalance as to whether the order could be forwarded to an exchange.

B. Example 2

FIG. 6 shows the same working buy order placed in FIG. 5, and inaddition it shows a working sell order placed in an outright market forJune. After placing the sell order, the trader still has no outrightsbecause neither order has yet to be filled. Thus, the outrights valueremains at 0. The maximum outrights also remains 1, which would occur ifeither the buy order or the sell order were filled thereby generatingeither a net long or a net short position (depending on which orderfills) for the trader.

If both the buy order and the sell order were to fill, the trader wouldseemingly have two outrights. This would not be the case, however,because if both orders filled then the trader would hold a net longposition in one month and a net short position in another month. The twooutright positions would combine to form a spread, with one leg of thespread being the March buy order and the second leg of the spread beingthe June sell order. Although both are held as outright positions, thepractical effect of these two countervailing positions is to hedge thetrader's risk the same as if trader traded a spread with the same twolegs. This occurs in spite of the fact that the trader traded the legsin an outright market instead of simply trading the spread in a spreadmarket. The O-Margin position remains “100” and the total positionremains “100.” The margin requirement is “100.”

C. Example 3

FIG. 7 shows that the working buy order placed in FIG. 5 has been filledand the working sell order placed in FIG. 6 remains in the market. Theoutrights value now becomes “1,” because the buy order filled and thetrader now holds one outright position. The maximum outrights remains“1.” As previously described, the maximum outrights for this exampleoccurs if either the buy order or the sell order fills, therebygenerating one outright for the trader. If both orders fill, the twowould combine to form a spread instead of two outright positions.

The maximum leg position for March becomes “1.” Note, however, that themaximum leg position for June remains at “0.” The margin requirementremains at “100.”

D. Example 4

FIG. 8 shows that the working sell order placed in FIG. 7 has beenfilled. The number of outrights is “0” since the total net long and thetotal net short are equal. Thus, instead of being treated as twoseparate outright positions, the March net long position combines withthe June net short position to create a spread. The total maximum legposition becomes “2.”

From the total maximum leg position and the number of outrights, thegeneric spread position can be found. In this example, one spreadexists. Hence, the S-Margin position is 10*1=10. The total position is10+0=10. The margin requirement is “10.”

E. Example 5

FIG. 9 shows that a working buy March/June spread order was entered. Thetotal maximum leg position now goes to “4.” The total outrights is still“0,” but the number of spreads goes to “2.” One spread from the filledpositions (net long and net short) and one spread from the workingbuy/sell spread. Therefore, the S-Margin position becomes 10*2=20. Thetotal position is 20+0=20. The margin requirement is “20.”

F. Example 6

FIG. 10 shows that a working buy March/June spread order was entered andfilled. So, the total net long is “2” and the total net short is “2.”The total maximum leg position remains at “4.” The total outrights isstill “0,” but the number of spreads remains at “2.” The S-Marginposition is 10*2=20. The total position is 20+0=20. The marginrequirement is “20.”

V. Displaying Relevant Information

The variables described in this application may be displayed. Forinstance, the variables including inputs into the system and outputsfrom the system can be displayed on a graphical user interface (GUI).The GUI can include any visual computer environment that representscomponents of the system with graphical images, such as icons, menus,and dialog boxes on the screen. Some examples of how and/or why onemight display such information are described directly below, butadditional reasons for displaying such information would be realized byone skilled in the art of trading upon reading the description herein.

According to one example, a trader can run the system in conjunctionwith other software that the trader uses to connect to an exchange andexecute trades. While the trader interacts with the exchange using theother software, the trader can simultaneously view the information totrack the margin requirements for the trader's positions and workingorders. This allows the trader to conveniently view his or her currentmargin balance, as it is updated in real-time. Limits which are imposedon the trader may also be displayed so as to inform the trader when alimit has been reached.

In another example, a group of traders can run the system and view theinformation as the system tracks the margin requirement for each of thetraders and/or tracks the margin requirement for the entire group. Themargin requirement for the entire group could be just the sum of themargin requirements for each trader. This allows the traders to viewtheir margin balance as a group, as it is updated in real-time. Similarto individual traders, limits which are imposed on the traders may bedisplayed to inform them when a limit has been reached.

In yet another example, an administrator or another user at a tradinghouse, clearing house, exchange, or other entity can view the marginrequirements for a particular trader or a group of traders. Thespreadsheet can be updated in real-time, and thus the administrator orother user can view the trader's (or traders') changing marginrequirements.

VI. Conclusion

The preferred embodiment described herein provides a quick and efficientway of computing risk associated with outright positions and spreadpositions for risk purposes. Current SPAN algorithms and similar riskmanagement solutions are often too complicated and time consuming to beused for real time (or near real time) pre-trade spread risk management.Therefore, a system and method were described herein to calculate therisk based in part on working outright orders and working spread ordersfor exchange traded spreads. A generic spread number is determined inaddition to a maximum outrights value, in which a margin requirement iscomputed. The computed margin requirement can be used in any fashionknown to one of ordinary skill in the art such as by limiting thetrading of one or more traders.

It should be understood that the programs, processes, methods andapparatus described herein are not related or limited to any particulartype of computer or network apparatus (hardware or software), unlessindicated otherwise. Various types of general purpose or specializedcomputer apparatus may be used with or perform operations in accordancewith the teachings described herein. While various elements of thepreferred embodiments have been described as being implemented insoftware, in other embodiments hardware or firmware implementations mayalternatively be used, and vice-versa.

In view of the wide variety of embodiments to which the principles ofthe present invention can be applied, it should be understood that theillustrated embodiments are exemplary only, and should not be taken aslimiting the scope of the present invention. For example, the steps ofthe flow diagrams may be taken in sequences other than those described,and more, fewer or other elements may be used in the block diagrams.

The claims should not be read as limited to the described order orelements unless stated to that effect. In addition, use of the term“means” in any claim is intended to invoke 35 U.S.C. §112, paragraph 6,and any claim without the word “means” is not so intended. Therefore,all embodiments that come within the scope and spirit of the followingclaims and equivalents thereto are claimed as the invention.

1. A method including: determining by a computing device a total maximumleg position based on maximum leg positions for each of one or moretradable objects, wherein the maximum leg positions represent a maximumposition in each leg; determining by the computing device a number oftotal outright positions based on a total filled net long position and atotal filled net short position, wherein the number of total outrightpositions represents the number of positions that are not consideredpart of a spread; determining by the computing device a number ofspreads based on (the total maximum leg position−the number of totaloutright positions)/2, wherein the number of spreads represents ageneric spread position; determining by the computing device a firstmargin requirement based on the number of spreads and a first basemargin value; determining by the computing device a maximum number ofoutrights based on a number of outrights due to working buy outrightorders and a number of outrights due to working sell outright orders,wherein the maximum number of outrights represents the maximum number ofoutright positions possible with a current configuration of outrightmarket working orders and filled positions; determining by the computingdevice a second margin requirement based on the maximum number ofoutrights and a second base margin value; determining by the computingdevice a total margin requirement based on the first margin requirementand the second margin requirement; and providing by the computing devicethe total margin requirement, wherein a decision to allow an order to besent is based on an available margin balance and the total marginrequirement.
 2. The method of claim 1, wherein the total maximum legposition is the sum of the maximum leg positions for each of the one ormore tradable objects.
 3. The method of claim 1, wherein the maximum legposition for each of the one or more tradable objects is based on afilled net long position, a filled net short position, an equivalent buyleg spread position, and an equivalent sell leg spread position.
 4. Themethod of claim 3, wherein a maximum leg position for one of the one ormore tradable objects is equal to maximum(absolute value(filled net longposition−filled net short position+equivalent buy leg spread position),absolute value(filled net long position−filled net shortposition−equivalent sell leg spread position)).
 5. The method of claim3, wherein the equivalent buy leg spread position and the equivalentsell leg spread position are provided by an exchange.
 6. The method ofclaim 1, wherein the number of total outright positions is equal toabsolute value(the total filled net long position−the total filled netshort position).
 7. The method of claim 1, wherein the total filled netlong position is based on filled net long positions for each of the oneor more tradable objects, wherein the total filled net short position isbased on filled net short positions for each of the one or more tradableobjects.
 8. The method of claim 7, wherein the total filled net longposition is the sum of all filled net long positions for each of the oneor more tradable objects, wherein the total filled net short position isthe sum of all filled net short positions for each of the one or moretradable objects.
 9. The method of claim 1, wherein the number ofspreads is equal to (the total maximum leg position−the number of totaloutright positions)/2.
 10. The method of claim 1, wherein the firstmargin requirement is equal to (the number of spreads*the first basemargin value).
 11. The method of claim 1, wherein the first base marginvalue is specified by one of a user, a trading house, a clearing house,and an exchange.
 12. The method of claim 1, wherein the maximum numberof outrights is equal to maximum (the number of outrights due to workingbuy outright orders, the number of outrights due to working selloutright orders).
 13. The method of claim 1, wherein one of the numberof outrights due to working buy outright orders and the number ofoutrights due to working sell outright orders includes the order. 14.The method of claim 1, wherein the number of outrights due to workingbuy outright orders is based on a total filled net position and a numberof working buy outright orders, wherein the number of outrights due toworking sell outright orders is based on the total filled net positionand a number of working sell outright orders.
 15. The method of claim14, wherein the number of outrights due to working buy outright ordersis equal to absolute value (the total filled net position+the number ofworking buy outright orders), wherein the number of outrights due toworking sell outright orders is equal to absolute value (the totalfilled net position−the number of working sell outright orders).
 16. Themethod of claim 1, wherein the second margin requirement is equal to(the maximum number of outfights*the second base margin value).
 17. Themethod of claim 1, wherein the second base margin value is specified byone of a user, a trading house, a clearing house, and an exchange. 18.The method of claim 1, wherein the total margin requirement is equal to(the first margin requirement+the second margin requirement).
 19. Themethod of claim 1, further including displaying by the computing devicethe total margin requirement.
 20. The method of claim 1, wherein thetotal margin requirement is determined for a group of traders.